Alternatives to Forming a Limited Liability Company

Forming a limited liability company often makes good business sense. An LLC limits your legal liability... and that's important. And an LLC offers tax benefits in some situations (in particular, the option to use the S corporation tax accounting rules).

Businesses, their owners and investors need to be aware, however, that reasonable "liability protection" alternatives to the limited liability company exist. An entrepreneur typically shouldn't jump into an LLC with considering these other options:

Liability Insurance as Alternative to LLC

In some cases, additional liability insurance amounts to a very reasonable alternative to the LLC option. For example, if you're looking to limit your liability as a landlord because you're investing in rental properties, at least look at the option of using additional liability insurance (including a personal liability umbrella policy) rather than limited liability companies.

You can often buy tons of liability insurance for a price that's less than the annual fees and franchise taxes that some states charge for registering a single limited liability company. For example, you may be able to buy a $5,000,000 personal liability umbrella policy for less than California charges in annual franchise fees.

Retirement Plans as Asset Protection Tools

Another option for liability protection? You can typically segregate the assets you want to protect inside containers that are themselves extremely safe. For example, to protect your investments and that's why you're isolating other risky assets or activities inside an LLC, you may want to look at the idea of storing your investments in a retirement account that is itself a form of protection.

In most states, money stored inside a retirement account is safe from most creditors, including judgment creditors created by worst-case-scenario lawsuits. Consider, for example, the situation of O.J. Simpson? Even though his ex-wife's family secured a large judgment against Mr. Simpson, perhaps his biggest asset, a multi-million-dollar NFL retirement account, was still protected.

Note: Typically states don't protect retirement funds from all creditors--just most. For example, in Washington state, child support claims can tap into retirement funds.

Re-title Assets

A simple idea? You may want to transfer title of valuable assets, thereby safely putting them out of danger.

As an example, and ask your attorney about this, but if you're married and one spouse engages in a risky profession or business, you may want to have the other, more safely-behaving spouse own the family home.

Behave More Safely and Simply Accept Left-over Risk

One final but often overlooked alternative should be mentioned. Obviously, you can minimize your legal risks by behaving cautiously. You can for example, avoid risky situations, people and activities. Cautious behavior, in and of itself, may so reduce your legal and business risks in a venture so as to make the remaining risks immaterial--or at least immaterial if you're adequately insured and if you're segregated some assets away into "armored" containers like retirement plans.

About the Author

Stephen L. Nelson is a CPA in Seattle, Washington and the co-author of a series of downloadable do-it-yourself kits for forming a limited liability company. A p part-time tax professor at Golden Gate University, he also teaches limited liability company taxation to other CPAs and attorneys.